Tuesday, November 13, 2012

There is so much written these days about how to attract investors that most entrepreneurs “assume” they need funding, and don’t even consider a plan for “bootstrapping,” or self-financing their startup. Yet, according to many sources, over 90 percent of all businesses are started and grown with no equity financing, and many others would have been better off without it.

According to the book, “Small Business, Big Vision,” by self-made entrepreneurs Adam and Matthew Toren, it’s really a question of need versus want. We all want to have our vision realized sooner rather than later, but it can be a big mistake to bring in investors rather than patiently building your business at a slow, steady pace (organic growth).

In fact, most of the rich entrepreneurs you know actively turned away early equity proposals. Too many founders are convinced they “need” equity financing, for the wrong reasons, as outlined in the book and supplemented with a bit of my own experience:

Need employees and professional services. Of course, every company needs these, in due time. In today’s Internet world, enterprising entrepreneurs have found that they can find out and do almost anything they need, from incorporating the company to filing patents, without expensive consultants, or the cost to hiring and firing employees.

Need expensive resources up front. Many people think that having a proper office and equipment somehow legitimizes their business, but unless your business requires a storefront, everything else can be done in someone’s home office, or a local coffee shop, on used or borrowed equipment. Consider all the alternatives, like lease versus buy.

Need to spread the risk. Some entrepreneurs seem to get solace and implied prestige from convincing friends, Angels, and venture capitalists to put money into their endeavor. If nothing else, these make good excuses for failure – no freedom, wrong guidance, etc.

On the other hand, there are clearly situations where your needs call for investors. Even in these cases, all other options should be explored first:

Sales are strong – too strong. If you are not able to keep up with demand due to lack of funds for production, and your company is too young for banks to be interested, you will find that investors love these odds, and are quick to go for a chunk of the action.

Your company has outgrown you. Some entrepreneurs are quick with creative ideas, and even excellent at managing the chaos of initial implementation. That’s not the same as instilling discipline in a larger organization, where most the challenge is people.

You need a prototype. When you have invented a new technology, you need expensive models and testing, including samples for potential customers. If you don’t have the personal funds to make these happen, investors might be your only option.

You need specialized equipment. If your solution depends on high-tech chips, injection molding, or medical devices, and you can’t get financing from suppliers, giving up a portion of the company to investors is a rational approach.

General startup expenses are beyond your means. Investors are not interested in covering overhead, unless they are convinced that you have already put all your “skin in the game” (not just sweat equity), and have real contributions from friends and family.

When deciding whether and how an investor can help you, remember that finding outside investors requires a huge amount of time and work, perhaps impacting your rollout more than working with alternate approaches and slower growth. Perhaps you really need an advisor rather than an investor.

Even under the best of circumstances, working with an investor requires give and take. More likely, you now have a new boss – which may be counter to why you chose the entrepreneur route in the first place. Maybe that’s why bootstrapped startups are the norm, rather than externally funded ones. You alone get to make the big decisions on your big vision.